USD: The Split USD. Neutral.
US data has continued to come in on the strong side, supporting our argument that the US output gap is closed and inflation should pick up. However, US real yields have remained muted, helping financial conditions stay loose and risk appetite stay supported, creating a sweet spot for EM. While the markets await further details on Trump's tax plans in the coming weeks, we expect the USD to continue underperforming high yield EM and outperforming the low yielders.
EUR: Looking Vulnerable. Bearish.
Eurozone political concerns have taken a breather for now, but the EUR has become negatively correlated with peripheral spreads in recent days, keeping the EUR in a vulnerable position should politics take centre stage again. Japanese investors have bought a large amount of French bonds in recent years, making the EUR at risk should they reduce their positions ahead of the French election. We hold on to our short EURUSD position and add short EURGBP to our portfolio this week.*
JPY: Back on Its Way Down. Bearish.
Recent commentary from BoJ's Kuroda and Nakaso have acknowledged the importance of bank profitability and the steepness of the yield curve, suggesting that they are likely to keep the yield curve control policy in place, pushing yield differentials against the JPY. The current positive risk environment should also keep the JPY weak. Historical sensitivity analysis suggests that JPY should underperform when US front end yields rise, thus US rates should be watched closely.
GBP: Buying Against EUR. Bullish.
We are now selling EURGBP in our portfolio as we see that the market has moved its focus away from worries after Brexit in an environment of carry support and market calm. PM May has set out her plans to trigger Article 50 in March with enough detail that should already be priced into GBP. GBP is currently undervalued and has stabilised, which we think offers a strategic opportunity to buy. The potential for FX reserves to be reallocated from EUR into GBP due to Eurozone political risks could also support the short EURGBP trade.*
CHF: SNB Allowing EURCHF to Fall. Neutral.
We continue to expect the SNB to smooth the downside in EURCHF but only to manage volatility and no longer to manage a level. In times of market uncertainty in the Eurozone and peripheral spread widening, we would look to sell EURCHF as a political hedge. After last week's referendum, the Swiss government is now going to have to come up with another way to limit the tax income reduction for the Cantons, which may eventually fall onto the SNB.
AUD: Housing In Focus. Bearish.
Iron ore prices rallying around 10% has kept the AUD supported but we see domestic risks emerging and so remain short AUDUSD in our portfolio. The RBA may have sounded more optimistic on growth but our economists expect a slowdown in the housing sector, which could trigger an RBA cut. New housing developments are expected to come on line soon.
NZD: Risks from Positioning. Neutral.
The carry currency support should feed through to the NZD too if dairy prices stay around current levels. Chinese consumer demand for dairy should continue to rise and the strong credit card spending in New Zealand in January, help the NZD. The RBNZ has removed its easing bias but we don't think they are in a position to hike this year. The services PMI rose rapidly in December, so we will be watching closely for the upside.
